Banks Are Still Holding Lots of Bad Loans

Seven years after the start of the financial crisis, banks are still holding big distressed loan portfolios. FDIC reports that as of June 30, 2015, non-current loans and other bank owned real estate totaled $162 billion.  That's a 63% decrease from mid 2010.  But it's nearly three times the $56 billion banks reported just before the crisis in mid 2006.

Why banks have held onto so many bad loans is not entirely clear.  One explanation might be that low interest make alternative investments relatively unattractive.  Non-current loans that are paying something may be more attractive than a sale to a distressed debt buyer and reinvestment of cash into low yielding alternative investments.  Many banks are holding non current loans because they are required to do so as part of loss sharing agreements with the FDIC. 

Inspector General's Report on the FDIC's Role in "Operation Choke Point"

The Office of the Inspector General's just released report is here.

Excerpt:  "We determined that the FDIC’s supervisory approach to financial institutions that conducted business with merchants on the [DOJ's] high-risk list was within the Corporation’s broad authorities granted under the FDI Act and other relevant statutes and regulations. However, the manner in which the supervisory approach was carried-out was not always consistent with the FDIC’s written policy and guidance."

Consumer Debt Negotiation: Is it Practice of Law?

Earlier this week the Connecticut Supreme Court held that Connecticut bank regulators must  keep their hands off lawyers who offer consumer debt negotiation services because the Connecticut constitution gives the judicial branch exclusive authority to regulate attorneys engaged in the practice of law.  The case is Persels & Assoc. LLC v. Banking Comm'r, 2015 BL 289966 (September 15, 2015).

Persels & Associates is a Maryland-based consumer advocacy law firm that offers assistance to consumers nationwide who are behind on their debts.  The case was about the effect of a Connecticut debt negotiation statute that authorized the Banking Commissioner to require attorneys who provide "debt negotiation services" to comply with licensing and registration requirements.  The statute was passed after the housing bubble burst in 2009 in response to the large number of consumer complaints about debt negotiation firms that tricked debtors in to paying up-front fees but not performing any debt negotiation work and sometimes making a debtor's circumstances worse.  The statute provided that before providing debt negotiation services a person must first obtain a license from the Banking Department and be subject to approval of financial responsibility, character reputation, integrity and general fitness.  The statute gave the banking commissioner power to investigate any debt negotiation transaction and discipline anyone who violated the law, including revocation of a debt negotiation license, disgorgement of fees, and a civil penalty up to $100K.  In deference to the judicial branch's power to regulate attorneys, the statute originally exempted from the licensing requirement attorneys who are admitted to practice in Connecticut and who engage in debt negotiation.  Around the time the Connecticut legislature passed its debt negotiation law, other states enacted similar laws, and the FTC passed rules governing debt negotiation businesses as amendments to its Telemarketing Sales Rule.

In 2011, the Connecticut legislature amended the attorney exception so it applied only to a subset of attorneys "who engage in or offer debt negotiation services as an ancillary matter to such attorney's representation of a client."   The 2011 amendment was passed to respond to a shift in the debt negotiation industry toward a model that used attorneys superficially to exempt the debt negotiation business from regulation that otherwise applied.  The commissioner observed:  "In many cases, newly admitted attorneys are employed by national debt negotiation firms and consumers are charged excessive fees for legal services that consist only of debt negotiation services."

In 2012, Persels & Associates asked the banking commissioner for a declaratory ruling to the effect that its method of offering debt negotiation services using Connecticut attorneys and persons supervised by them was within the exception from the license requirement.  The commissioner opened the matter to public comment which did not go well for Persels & Associates. Many of the comments accused Persels & Associates of misrepresenting its business model.  They said that the the firm does not engage in the practice of law, but rather is a debt negotiation company masquerading as a law firm solely to avoid consumer protection regulation.  Others pointed to the pile up of complaints, lawsuits and administrative enforcement actions against the firm in other states and to the FTC.  The commissioner declined to issue a declaratory ruling.  Instead, he determined that the attorney exception applies only to s a member of the Connecticut bar who "is not retained to perform, and does not perform, debt negotiation services. . . as the primary purpose of the representation.... "  The commissioner determined that because Persels & Associates uses non-lawyers (along with lawyers) to render debt negotiation services, it would need a license and would be subject to all the other provisions of Connecticut debt negotiation law.

Persels & Associates appealed and the Superior Court affirmed, finding that as a matter of law it was proper for the commissioner to construe the attorney exception to adopt a "primary purpose test" so that an attorney would not be entitled to the exception whenever debt negotiation is the primary purpose of the relationship with the client.  The Superior Court held that because debt negotiation does not constitute the practice of law, the attorney exception as construed by the commissioner, does not unconstitutionally delegate to the Banking Department the authority to license and regulate the practice of law.

The Connecticut Supreme Court reversed with respect to Persels & Associates' constitutional claim and the trial court's conclusion that debt negotiation services are not the practice of law.  It argued that the way the commissioner construed and applied the statute in its case, Connecticut's debt negotiation statute impermissibly intruded on the judicial branch's exclusive authority to regulate attorney conduct.  In particular, the debt negotiation statute as the commissioner interpreted it would give the commissioner authority to determine which Connecticut attorneys have the "character, reputation, integrity and general fitness" to provide debt negotiation services to a client in the course of representation, would require them to pay license fees to a legislative agency as a condition to offering legal services, and would encroach on the power of the judicial branch to suspend or disbar attorneys who engage in professional misconduct.  "No statute can control the judicial department in the performance of its duty to decide who shall enjoy the privilege of practicing law" and any attempt by the legislature to direct the rules that govern attorneys crosses the constitutional line between the judicial and legislative branches.

The court also agreed with Persels & Associates that debt negotiation services can be the practice of law.   The fact that a non-attorney may provide basic debt negotiation services in Connecticut without violating Connecticut's debt collection statute does not mean those services are not the practice of law when an attorney performs them in the course of an attorney client relationship. The  court concluded with a warning for debt negotiators and lawyers.  If the commissioner can establish in a particular case that a debt negotiation company was using Connecticut attorneys as a facade to circumvent the debt negotiation statute, "there would be no separation of powers problem" and the commissioner would be entitled to exercise his full statutory authority.  Attorneys who are engaged in debt negotiation and are not acting as attorneys fall outside the scope of the Rules of Professional Conduct and the exclusive regulatory authority of the judicial branch.  Moreover, attorneys engaged in debt negotiation who are acting as attorneys are subject to the Rules of Professional Conduct that preclude attorneys from charging an unreasonable fee for their services.  "We likewise trust that Connecticut attorneys, both newly admitted and experienced, will remain mindful of the potential ethical pitfalls they may encounter in this area of practice."

Another Banker Sentenced

United Commercial Bank was the first bank to fail after receiving TARP bailout funding from the federal government.  Last week, one of its top executives was sentenced to eight years in prison. Ebrahim Shabudin was convicted for falsifying bank records to hide bank losses from regulators. The failure of United Commercial Bank in 2009 cost the FDIC and US taxpayers more than $675 million. Here's the Washington Post story.   Here's a list of investigations undertaken by SIGTARP, a federal investigative task force set up to go after banks and bankers who misused TARP bailout finds.  

No Bankruptcy Relief for Marijuana Business

Marijuana sales for medical and recreational use is legal in several states.  But, it's a crime under federal law.  What happens when a marijuana business fails?

Frank and Sara Arenas owned a building in Denver with two units.  In one, Frank grew and sold marijuana wholesale.  He leased the other unit to tenants to dispense marijuana for medical use. The tenant sued Arenas over an issue with the lease and obtained a judgment against him.  Arenas filed for bankruptcy and the United States Trustee asked the bankruptcy court to dismiss Arenas's case.  (A US Trustee is an agent of the US Department of Justice responsible for monitoring bankruptcy cases for fraud and protect the integrity of the system). Although Arenas's medical marijuana business was legal under Colorado law, it violated the federal Controlled Substances Act (CSA).

The 10th Circuit BAP considered Arenas's case late last month.  Arenas v. United States Trustee (In re Arenas), 2015 Bankr. LEXIS 2821 (B.A.P. 10th Cir. Aug. 21, 2015):

The pivotal issue here is whether engaging in the marijuana trade, which is legal under Colorado law but a crime under federal law, amounts to "cause" including a "lack of good faith" that effectively disqualifies these otherwise eligible debtors from bankruptcy relief. We agree with the bankruptcy court that while the debtors have not engaged in intrinsically evil conduct, the debtors cannot obtain bankruptcy relief because their marijuana business activities are federal crimes.

 Arenas had argued unsuccessfully in his brief  before the BAP the hypocrisy of the federal government in tolerating Colorado's legalization of marijuana businesses. Twenty three states and the District of  Columbia have legalized medical marijuana use, while such use remains a federal crime.